Manufactured housing can be a sensitive subject, and while I understand if some investors are turned off by the ethics of swooping in, acquiring a low-income housing area, and then raising rents, I try to separate myself from the politics and purely look at the investment thesis.
To some, Sun Communities may seem like a fairly run-of-the-mill high growth, low yield play on housing like Avalon Bay Communities (AVB) or Essex Property Trust (ESS). However, I think the nearly 4x total return outperformance over the past 5 years compared to these companies is a result of:
-Significantly higher NOI growth
-Higher occupancies and more “stickiness” (14 year average length of stay)
-Operating in a niche, fragmented market without a lot of public competition
-Cheap housing in the face of rising home prices and historical undersupply
Most of this is still true today, although I would say that manufactured housing has received plenty of attention on Seeking Alpha due to its huge average annual Net Operating Income growth.
The strengths that I listed could also be said of Equity LifeStyle Properties (ELS), which is a close peer of Sun Communities. However, this article will focus on the latter.
Image from Yahoo Finance
In the chart above, you can clearly see how the high NOI growth has fueled ELS and SUI to double the returns of the S&P 500 over the past five years. UMH Properties (UMH) in red, however, has been rather disappointing, and I would guess that this has to do with its high-risk, high-yield REIT equities portfolio.
The last time SUI was as cheap as it is today was after the beginning of the pandemic started and the market was crashing in early-mid March. Much of the story around REITs has been with re-opening and rent collections, and while I will touch on those important metrics, housing should be relatively immune from these challenges. The business model of acquiring sites, improving both the quality and number of sites, and then raising rents has not changed. In fact, the pandemic’s blow to the economy may serve as a tailwind for SUI going forward.
Image from SUI investor presentation 7/23/2020
Q2 2020 Earnings
Sun Communities reported an FFO beat, coming in at $1.12 per share, despite revenue being off 2.9% YoY. Part of the reason for differences in QoQ numbers has to do with the seasonality of home sales, which are typically highest in the third quarter and somewhat higher in the first quarter. That important NOI growth was a little low at 1.4% for the quarter, but if you exclude some pandemic-related expenses, it would have come in at 2%.
Same-store occupancy increased from 96.8 to 98.7% from the year-ago quarter, which shows high demand for its properties and the ability to increase rents without disrupting occupancy. Total occupancy increased 0.7% YoY. The company added a net of 1219 sites through acquisitions and dispositions YTD.
For the important COVID-19 metrics, Q2 rent collection stood at 97% for manufactured housing and 98% for the Annual RV segment. Over 17% of deferred rent has already been paid back, which points to there being little interruption for SUI going forward. The REIT was able to furlough some of its property-level workforce, which helped margins, but the majority of them are back at work now, so we should expect to see expenses in line with normal in the quarters to come.
Why Invest in Manufactured Housing as opposed to Apartments?
I happen to think investing in apartment REITs to be a fine choice, and many of them have done very well over the years. For the past five years, and perhaps going forward, I think manufactured housing deserves a place in your portfolio. Past performance is not indicative of future results, but it is an interesting fact that SUI has beaten AvalonBay Communities by about 105% in total return over the past five years (~28.4x as much return) and Equity Residential (EQR) by even more (108.73% vs. 1.65%). I think part of this has to do with relative rents and the ability to raise them. EQR’s average rent is $2875 a month, and AVB is at $2709. Sun Communities’ MH monthly rent is $593 and its RV rent is $499. While EQR has been successful at raising average rents (AVB has had its decline in the most recent quarter), SUI is able to do so at nearly twice the rate.
I have really started to appreciate a company’s ability to value-add to its assets, which is one of the many reasons that I like REITs like Sun Communities and Federal Realty Trust (FRT), for example. Instead of buying a class A apartment at a mid-4% cap rate (like the above apartment REITs) and being relatively unable to value-add and expand your returns, SUI (and FRT) scoop up lower-quality, higher-yielding properties and improve them, allowing them to charge higher rates. This type of organic investment is something that SUI does very well, and the company has the ability to expand its current portfolio by ~9742 sites, which would be an increase of 8% of its portfolio.
The market meltdown saw many overleveraged companies punished for their perceived lack of liquidity and safety. Sun Communities does not share this problem:
Image from SUI investor presentation 7/23/2020
During the quarter, it did raise $633 million through a secondary equity offering at around the $132 mark. This seemed poorly timed, as the company was still way off its highs, but at the time, we weren’t sure exactly what the world was going through. Cash on hand of $373.5 million at the end of the quarter is relatively the same amount as last quarter. The company primarily used the proceeds from the stock sale to pay off some debt and fund a few aforementioned acquisitions. I support this move, and the Net Debt-to-Recurring EBITDA is highlighted as 4.8x in the picture above. This is pretty low for a highly predictable income stream like SUI. More importantly, the weighted average maturity of the debt is 11.6 years, and there isn’t any significant amount due until 2022/2023.
The dividend yield of 2.25% is nothing to write home about, but the company does a good job of raising it every year. The 3-year growth rate of 4.89% is about right for a growth stock like this one. Remember, total return is what matters, so although retirees probably aren’t excited about the low income prospects, it hasn’t doubled the return of the market over the last 5 years by chance.
TTM FFO of $4.9 a share means that the annual payout of $3.16 represents a 64.5% payout ratio, which is among the lowest you’ll see. This, along with the $683 million available on the credit facility, means that the company has plenty of liquidity.
I was surprised to see Sun Communities fall by 40% from peak to trough from the market crash in March given the fact that it is a fantastically run company that provides cheap housing. Increasing occupancy, base rents and NOI point to the fact that this company will be completely unaffected by current events. If anything, an expansion of stimulus benefits will cover a month’s rent with some money left over to spare. The growth story remains intact, and I see no reason not to layer in at current prices.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Long SUI and ELS: 1/3rd of my work retirement account is the mutual fund TIREX. 4% of TIREX is SUI, 3.68% is ELS.